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Title: Tariffs and Nontariff Barriers


1
International Economics
Chapter 4
  • Tariffs and Nontariff Barriers

2
Chapter 4 Tariffs and Nontariff Barriers
  • 4.1 Theories for Trade Protection
  • 4.2 Tariffs
  • 4.3 Nontariff Trade Barriers

3
4.1 Theories for Trade Protection
  • Infant Industry Argument
  • This argument contends that for free trade to be
    meaningful, trading countries should temporarily
    shield their newly developing industries from
    foreign competition.

4
4.1 Theories for Trade Protection
  • Some truths in the infant industry argument
  • Once a protective tariff is imposed, it is very
    difficult to remove, even after industrial
    maturity has been achieved.
  • It is very difficult to determine which
    industries will be capable of realizing
    comparative advantage potential and thus merit
    protection.
  • The argument generally is not valid for mature,
    industrialized countries.
  • There may be other ways of insulating a
    developing industry from cutthroat competition.
    Rather than adopt a protective tariff, the
    government could grant a subsidy to the industry.

5
4.1 Theories for Trade Protection
  • Terms of Trade Argument
  • In some cases, the terms of trade benefits of a
    tariff outweigh its costs, so there is a
    terms-of-trade argument for a tariff.
  • The terms of trade argument against free trade,
    then, is intellectually impeccable but of
    doubtful usefulness.
  • In practice, it is emphasized more by economists
    as a theoretical proposition than it is used by
    governments as a justification for trade policy.

6
4.1 Theories for Trade Protection
  • Domestic Market Failure Argument
  • Theory of the second best
  • When economists apply the theory of the second
    best to trade policy, they argue that
    imperfections in the internal functioning of an
    economy may justify interfering in its external
    economic relations.
  • This argument accepts that international trade is
    not the source of the problem but suggests
    nonetheless that trade policy can provide at
    least a partial solution.

7
4.1 Theories for Trade Protection
  • Strategic Trade Policy
  • Because of the small number of firms, the
    assumption of perfect competition does not apply.
    There are only a few firms in effective
    competition in some industries.
  • This argument locates the market failure that
    justifies government intervention in the lack of
    perfect competition.
  • It is possible in principle for a government to
    alter the rules of the game to shift these excess
    returns from foreign to domestic firms.

8
Chapter 4 Tariffs and Nontariff Barriers
  • 4.1 Theories for Trade Protection
  • 4.2 Tariffs
  • 4.3 Nontariff Trade Barriers

9
4.2 Tariffs
  • A tariff is simply a tax (duty) levied on a
    product when it crosses national boundaries.
  • Import tariff v.s. Export tariff
  • Protective tariff v.s. Revenue tariff
  • Types of Tariffs
  • Specific Tariff
  • Ad Valorem Tariff
  • Compound Tariff

10
4.2 Tariffs
  • Effective Rate of Protection (ERP)
  • the percentage change in the value added in an
    industry because of the imposition of a tariff
    structure by the country rather than the
    existence of free trade.

11
4.2 Tariffs
  • Calculation of ERP (Way I)

12
4.2 Tariffs
  • Calculation of ERP (Way II)

13
4.2 Tariffs
  • Three general rules about the relationship
    between nominal rates and effective rates of
    protection
  • If the nominal tariff rate on the final good is
    higher than the weighted average nominal tariff
    rate on the inputs, then the ERP will be higher
    than the nominal rate on the final goods
  • If the nominal tariff rate on the final good is
    lower than the weighted average nominal tariff
    rate on the inputs, then the ERP will be lower
    than the nominal rate on the final goods
  • If the nominal tariff rate on the final good is
    equal to the weighted average nominal tariff rate
    on the inputs, then the ERP will be equal to the
    nominal rate on the final goods.

14
4.2 Tariffs
  • Two consequences of the effective rate
    calculation
  • The degree of effective protection increases as
    the value added by domestic producers declines.
  • In the formula, the higher the value of aij
    is, the greater the effective protection rate for
    any given nominal tariff rate on the final
    product will be.
  • A tariff on imports used in the production
    process reduces the level of effective
    protection.
  • In the formula, as ti rises, the numerator of
    the formula decreases and hence ERP decreases.

15
4.2 Tariffs
  • Conclusion
  • when material inputs or intermediate products
    enter a country at a very low duty while the
    final imported commodity is protected by a high
    duty, the result tends to be a high protection
    rate for the domestic producers. The nominal
    tariff rate on finished goods thus understates
    the effective rate of protection.
  • But should a tariff be imposed on imported inputs
    that exceeds that on the finished good, the
    nominal tariff rate on the finished product would
    tend to overstate its protective effect.

16
4.2 Tariffs
  • Tariff Escalation
  • The tariff structures have generally been
    characterized by rising rates that give greater
    protection to intermediate and finished products
    than to primary commodities.
  • The tariff structures of the industrialized
    countries may indeed discourage the growth of
    processing, thus hampering diversification into
    higher value-added exports for the less developed
    countries, worsening the potential competitive
    position of the less-developed countries in the
    manufacturing and processing sectors.

17
4.2 Tariffs
  • Tariff Welfare Effects
  • Consumer Surplus
  • Consumer surplus refers to the difference between
    the amount that buyers would be willing and able
    to pay for a good and the actual amount they do
    pay.
  • Producer Surplus
  • Producer surplus is the revenue producers receive
    over and above the minimum amount required to
    induce them to supply the good.

18
4.2 Tariffs
19
4.2 Tariffs
  • Trade Welfare Effect of Tariff in a Partial
    Equilibrium Setting
  • The Small-Nation Case

20
4.2 Tariffs
  • The redistributive effect (Area a)
  • the transfer of consumer surplus, in monetary
    terms, to the domestic producers of the
    import-competing product.
  • The protective effect (Area b)
  • the loss to the domestic economy resulting from
    wasted resources used to produce additional cloth
    at increasing unit costs.
  • The domestic revenue effect (Area c)
  • the tariff proceeds paid by country As consumers
    to its government.
  • The consumption effect (Area d)
  • arises from the decrease in consumption resulting
    from the tariff's artificially increasing the
    price.
  • The deadweight loss (Areas b d)
  • represents a real cost to a community, not a
    transfer to other sectors of the economy.

21
4.2 Tariffs
Welfare Cost of a Tariff Imposed by a Small
Nation
  • Levying an import tariff, therefore, reduces a
    small country's welfare.

22
4.2 Tariffs
  • The Large-Nation Case
  • The equilibrium world price is defined as the
    price at which the quantity that consumers in
    Country A want to import is equal to the quantity
    that producers in Country B want to export. In
    the diagram, this price is denoted by PFT.

International Free-Trade Equilibrium
23
4.2 Tariffs
  • The size of the tariff equals the difference
    between the price consumers in country A pay for
    the product (PT) and the price producers in
    country B receive (P'). That is, the per unit
    tariff of t equals PT -P' .

24
4.2 Tariffs
  • The redistributive effect (Area a)
  • the transfer of consumer surplus, in monetary
    terms, to the domestic producers of the
    import-competing product.
  • The protective effect (Area b)
  • the loss to the domestic economy resulting from
    wasted resources used to produce additional cloth
    at increasing unit costs.
  • The domestic revenue effect (Area c)
  • the tariff proceeds paid by country As consumers
    to its government.
  • The consumption effect (Area d)
  • arises from the decrease in consumption resulting
    from the tariff's artificially increasing the
    price.
  • The terms of trade effect (Area e)
  • the amount of the tariff revenue paid by
    foreigners because the world price of their
    exports has fallen.

25
4.2 Tariffs
  • The change in welfare in country A brought about
    by the imposition of a tariff equals e-(bd).
    This amount could be positive or negative,
    depending on the relative sizes of the two terms.
  • Optimal tariff the tariff would be set to a
    level that maximizes the area e-(bd).

26
4.2 Tariffs
  • Trade Welfare Effect of Tariff in a General
    Equilibrium Setting
  • The Small-Nation Case

27
4.2 Tariffs
  • The reduction in welfare comes from two effects
  • The economy no longer produces at a point that
    maximizes the value of income at world prices.
    The budget constraint that passes through B1 lies
    inside the constraint passing through B0.
  • Consumers do not choose the welfare-maximizing
    point on the budget constraint they do not move
    up to an indifference curve that is tangent to
    the economy's actual budget constraint.

28
4.2 Tariffs
  • The Large-Nation Case

With the imposition of a tariff, Country Is
offer curve OCI shifts inward to OCI'.
29
4.2 Tariffs
The Impact of a Tariff
The equilibrium quantity of exports falls from
OB1 to OB2, and the quantity of imports falls
from OA1 to OA2. Country Is terms of trade
improve from TOT1 to TOT2.
30
Chapter 4 Tariffs and Nontariff Barriers
  • 4.1 Theories for Trade Protection
  • 4.2 Tariffs
  • 4.3 Nontariff Trade Barriers

31
4.3 Nontariff Trade Barriers
  • An Introduction to Nontariff Trade Barriers
  • Import Quota
  • An import quota is a physical restriction on the
    quantity of goods that may be imported during a
    specific period the quota generally limits
    imports to a level below which imports would
    occur under free-trade conditions.
  • A common practice to administer an import quota
    is for the government to require an import
    license. Each license specifies the volume of
    imports allowed, and the total volume allowed
    should not exceed the quota.
  • Import quotas on manufactured goods have been
    outlawed by the World Trade Organization.

32
4.3 Nontariff Trade Barriers
  • Tariff-Rate Quota A Two-Tier Tariff
  • a tariff-rate quota displays both tariff-like
    and quota-like characteristics. This device
    allows a specified number of goods to be imported
    at one tariff rate (the within-quota tariff
    rate), whereas any imports above this level face
    a higher tariff rate (the over-quota tariff
    rate).
  • a tariff rate quota is a two-tier tariff.

33
4.3 Nontariff Trade Barriers
  • Orderly Marketing Agreements
  • An orderly marketing agreement (OMA) is a
    market-sharing pact negotiated by trading
    partners.
  • Its main purpose is to moderate the intensity of
    international competition, allowing less
    efficient domestic producers to participate in
    markets that would otherwise have been lost to
    foreign producers who sell a superior product at
    a lower price.
  • A typical OMA consists of voluntary quotas
    applied to exports. These controls are known as
    voluntary export restraints (VERs) they are
    sometimes supplemented by backup import controls
    to ensure that the restraints are effective.

34
4.3 Nontariff Trade Barriers
  • Domestic Content Requirements
  • To limit the practice of outsourcing, organized
    labor has lobbied for the use of domestic content
    requirements.
  • The effect of content requirements is to pressure
    both domestic and foreign firms who sell products
    in the home country to use domestic inputs
    (workers) in the production of those products.
  • Manufacturers generally lobby against domestic
    content requirements, because they prevent
    manufacturers from obtaining inputs at the lowest
    cost, thus contributing to higher product prices
    and loss of competitiveness.

35
4.3 Nontariff Trade Barriers
  • Subsidies
  • National governments sometimes grant subsidies
    to their producers to help improve their trade
    position.
  • Governmental subsidies assume a variety of forms,
    including outright cash disbursements, tax
    concessions, insurance arrangements, and loans at
    below-market interest rates.
  • Two types of subsidies
  • a domestic subsidy which is sometimes granted to
    producers of import-competing goods
  • an export subsidy which goes to producers of the
    goods that are to be sold overseas.

36
4.3 Nontariff Trade Barriers
  • Dumping
  • Dumping is recognized as a form of international
    price discrimination.
  • It occurs when foreign buyers are charged lower
    prices than domestic buyers for an identical
    product, after allowing for transportation costs
    and tariff duties. Selling in foreign markets at
    a price below the cost of production is also
    considered dumping.
  • Commercial dumping is generally viewed as
    sporadic, predatory, or persistent in nature.
    Each type is practiced under different
    circumstances.

37
4.3 Nontariff Trade Barriers
  • The effects of an Import Quota
  • In the absence of trade, equilibrium would occur
    at Point E with the domestic price of cloth
    equaling P.
  • The free-trade equilibrium is located at Point F,
    the domestic price of cloth would fall to the
    world price PW.
  • The imposition of the quota changes the amount of
    cloth supplied to the importing country, a new
    equilibrium is reached at G.

38
4.3 Nontariff Trade Barriers
  • The country loses Areas bcd under a quota.
  • The redistributive effect (Area a)
  • The protective effect (Area b)
  • The domestic revenue effect (Area c)
  • Area c accrues to the foreign producers and makes
    them more profitable.
  • The consumption effect (Area d)
  • The deadweight loss (Areas b d)

39
4.3 Nontariff Trade Barriers
  • Two methods available for a government or
    community to capture Area c from foreign
    producers under a quota.
  • The domestic government could auction quotas to
    importers in a free market. The limited quota
    supply would go to those importers most in need
    of the product who would pay the higher price.
  • Convert the quota into an equivalent tariff.

40
4.3 Nontariff Trade Barriers
  • Quota and equivalent tariff
  • The losses for consumers and community are much
    larger in the case of a quota than in the case of
    a tariff when demand increases.

41
4.3 Nontariff Trade Barriers
  • The Effects of an Export Subsidy
  • Consumers lose Area ab in the form of higher
    taxes.
  • Producers gain Area a in profits.
  • The cost to the community is Area b, that is the
    production deadweight cost of the subsidy.
  • Subsidies are superior to protection in another
    way they are more visible.
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